Oil Price Tanks Globally

Despite OPEC and Russia working together to cut production of oil, the oil price still tanked globally. The oil market suffers as a lack of demand grows since people around the world are in quarantine. Global oil prices fell about 40% so far, making for the largest one-day drop in modern history. Some producers are even paying people to take barrels of oil as storage space minimizes.

Canadian oil prices turned down this Monday, dropping into negative price territory for – $0.01. In Alberta, their trading dropped even further to -$4.68 a barrel Monday morning. Landlocked producers are among those who are willing to pay people to take barrels of the oil surplus. This includes Alberta’s oilsands and US producers with limited access to global oil shipping routes.

The West Texas Intermediate fell to $10.77 USD per barrel on Monday, too. 

Why are the oil prices dropping now?

Much of the world has been in quarantine since March, and the shelter-in-place state most countries find themselves in continues through April. So why is the oil price tanking now? You might remember in February/March the oil price war between Russia and Saudi Arabia. This war did not help the future for oil because this price war began to establish the surplus producers face now. 

Even though OPEC and Russia came to an agreement about cutting production for the time being, the cuts were not enough to soften the blow to the market from the pandemic. This cut was about 10% of the world’s supply, meaning 9.7 million barrels per day. Airlines and other modes of transportation make up a great deal of the world’s demand for oil. Flight cancellations have greatly impacted this drop in demand in addition to individual consumers. Worldwide, demand is down about 25-35%. 

Oil prices are also dropping not only because of extremely limited demand, but also because investors’ May oil futures contracts expire this week. 

Another factor for the oil price drop includes the fact that space is running low. It was reported that storage space in Cushing, OK, the location for the planned Keystone XL Pipeline, is almost gone. 

Market Mechanics and Statistics

Oil prices have suddenly dropped because the May oil futures contract expires this week. Market mechanics explains the drop because less are trading for the front month. This feeds volatility. 

  • May oil futures contract was down into negative price territory at -$37.63. This means that producers are willing to pay companies to take oil deliveries. 
    • Main consumers (aircrafts and manufacturers) have slashed demand because quarantine calls for less travel and business operations
    • Individual consumers (drivers) also have significantly less demand from working at home, unemployment, and business closures.
  • June NYMEX crude oil futures on Tuesday are down around 35% at $16.40 per barrel on Tuesday. 
  • July oil futures are about $23 per barrel, dropping 11%.
  • Brent crude oil futures are trading just above $18 even though it fell 25% this week.
  • Benchmark Brent Crude is in bear, trading 15.5% lower at about $22 a barrel.

The spread between the front month (May) and the second month (June) is the widest gap in history. The issue is there are very few in the US who want oil in the short term. Even OPEC++ making the biggest cut in history for oil was not enough to prevent the oil price plunge. These cuts are set to start on May 1st, but it is not certain how this will affect oil prices in the future. There is still a severe lack of storage that may continue for the next 4-6 weeks.

Investors backing off oil goes to show they are worried about the lasting damage of the coronavirus on the economy. Instead, investors have turned to other stocks and investments, including precious metals, which are also related to the oil price. 

What is going to happen to oil companies?

With this unprecedented drop in oil demand, people are unsure of the future for the oil companies. Some companies stockpile oil now if they have space, but some analysts suggest that certain oil producers should keep drilling even though demand is low. This is because it is cheaper for some companies instead of closing and then restarting production later. For example, the oilsands mines in Canada and shale-oil operations in the US are two that might stay open instead of shuttering the company and reopening in the future. 

Additionally, oil companies cannot simply turn off the oil drills and turn them back on later. The oil has to go somewhere. If an oil well is shut down, there is no guarantee that it will work properly when it’s time to reopen. There’s only so much supply they can cut for this reason, even though silos and boats are at full storage capacity. This will most likely impact June and July futures deliveries, possibly mimicking the front month and plunge into negatives. It is also worth noting that individuals cannot take on the physical delivery of oil futures in “bulk.”

The Prime Minister of Canada, Justin Trudeau declared sending aid to the oil and gas industry. This aid comes in the form of $2.5 billion, and $1.7 billion of this amount is to help clean up abandoned oil wells.

As for the US, oil prices nosedived as well. Monday, the oil price collapsed down to $0, and then into negatives like -$37.63 per barrel. This is the first time in history that the oil price fell below $0, and is the lowest level of trading since NYMEX opened oil futures in 1983. 

Stocks This Week

Stocks up on Monday included Coca Cola (KO), Netflix (NFLX), Delta (DAL), IBM (IBM), and Intel (INTC). Overall, 43% of companies missed Wall Street’s predictions, which is on the way to becoming the highest rate since 1998. The S&P 500 jumped three out of four of the last few weeks after falling into the fastest nosedive into bear market territory.

Deutsche Bank Strategist Jim Reid told clients on Monday that this is probably one of “…the worst synchronized global economic slumps in history against the largest intervention ever.” Deutsche Bank also noted that top central banks have expanded their balance sheets by $2.7 trillion, and 2/3 came from the US Federal Reserve (CNN).

Overall it is uncertain how long this lockdown will last around the world, especially if there are second waves of the virus. Advisors are warning people against riskier investments at this time. Lastly, what will show the current state of the economy is U.S. economic reports due for release today. This involves the weekly Goldman Sachs and Johnson Redbook retail sales reports and existing home sales.

Gold Futures Crisis

While the oil price sees massive drops and a shaky future, gold is seeing the opposite effect. There is currently a shortage of gold. Even though the gold spot price was down Tuesday morning, businesses like refineries are still partially or fully closed. This includes Swiss refineries that account for approximately ⅓ of the world’s annual gold supply and the US Mint’s West Point facility.

Although oil futures are seeing what happens when you have an oversupply of a commodity and no one that wants to take physical possession of that commodity, gold and silver are currently seeing what’s known as “contango.” The gold and silver futures markets are trading significantly above the spot price market. This is a result of too many buyers wanting to take physical delivery of their gold and silver futures, and there is a limited supply to meet demand.  Banks and other large institutions may be heavily short and now are unable to deliver on those contracts, thus driving prices and premiums on those metals to unprecedented levels.  

When really looking into the current situations, it becomes clear how broken the Comex marketplace is. It also shows how overleveraged some of these underlying commodities are that are traded on the exchanges. We might be seeing the beginning of a massive price divergence between the spot market prices (aka paper market) and the actual physical market for commodities on the Comex and other exchanges.  

Precious Metals Analysis

Safe-haven assets were doing well and then fell this Tuesday morning alongside the oil price. This is because spooked investors are hanging by the sidelines, but long-term traders are buying futures.

Gold Spot Price 24 hour chart Bullion Exchanges
Silver spot price 24 hour chart Bullion Exchanges

Despite the spot prices of most metals tumbling and rising, gold futures contracts and premiums are significantly higher than the stock market. This is the exact opposite of oil. Comex has a shortage of gold and to deliver on their contracts, rules had to be changed for the form of gold delivery to be acceptable. Comex is currently in trouble because of the gold shortage.

Gold futures were last down $33.20 per ounce at $1,678.20. May Comex Silver was last down $0.804 at $14.81/oz. US Dollar index is higher on safe-haven demand, but the US Treasury note is trading around 0.575% on Tuesday morning. This is a recent drop and shows higher anxiety of investors in the marketplace. 

George Gero, the managing director with RBC Wealth Management suggested long-term traders are the ones bringing up the gold futures prices.

[…] gold could remain strong even if the U.S. dollar does likewise. ‘In the past, when you had strength in the dollar, you would have a sell-off in gold, but no longer,’ Gero said. In the current environment, traders have often bought both gold and the dollar at the same time as a safe haven, he explained. Further, he said, when the dollar rises, it’s not because of U.S. interest-rate increases, which hurt gold, but is instead because of weak economic fundamentals in other countries hurting their currencies even more.

From Kitco.

In conclusion, the price divergence of gold and oil will change, but only oil can trade negative. You will always find someone willing to take physical delivery of gold. This price will continue to move, however, based on the current volatile economic and political events.

Bullion Exchanges

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Disclaimer. This article is not meant to serve as professional economic advice. Any action you take upon the information from this article and website is strictly at your own risk.

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